2015 (11) TMI 1911 - AT - Income Tax

Transfer-pricing officer and DRP reject CUP for lack of identical products; TNMM upheld as most appropriate method

ITAT-Bang held that the transfer-pricing officer and DRP rightly rejected the CUP method for lack of evidence that purchases from AE and non-AE were for ... TP Adjustment - selection of MAM - rejection CUP method and using TNMM as the MAM by the TPO for determining the ALP - HELD THAT:- TPO as well as the DRP that the assessee failed to establish that the purchases made from AE as well as non-AE are in respect of identical products/items. In the absence of similarity of product purchased from AE and non-AE, CUP method cannot be applied as MAP for determining the ALP. Accordingly, no error or illegality in the order of the authorities below in rejecting the CUP method and adopting the TNMM. Assessee has even not furnished any detail before us in support of its claim. Even the details of the ratio of purchases from AE and non-AE has also not been furnished by the assessee. It is a clear case where the necessary information was not furnished by the assessee and therefore, in these circumstances, CUP method cannot be adopted as the MAM. Comparable selection - SPEL Semiconductor Ltd - Semi-conductor in itself is not a device but only a component to be used in various devices. The assessee is also manufacturing and assembly of opto-electronic equipments. Therefore, the activity of the assessee as well as this comparable company are functionally comparable. As regards the other objections raised by the assessee, we find that the assessee has first time raised this objection of difference in fixed assets. It is pertinent to note that even if there is difference in the fixed assets which is much high than the assessee, does not adversely affect the interest of the assessee but the cost of the fixed assets would rather reduce the operating margin of the comparable company. Further the cost of the fixed assets alone is not a determining factor for comparability if the corresponding turnover is also higher and therefore, the cost of fixed asset is diluted and not effecting the margin negatively due to the availability of economics of scale in the manufacturing industry. Therefore, we do not find any substance in the objection raised by the assessee on this account. Centum Electronics Ltd. - Objections of the RPT was not taken by the assessee before the authorities below and therefore, the AO as well as the DRP had no occasion to examine this fact of RPT in case of this company. Accordingly, we set aside the comparability of this company to the record of the TPO/AO for verification of the fact regarding RPT and decide the same as per law. Needless to say if it is found that the RPT of this company is more than 25% then this company cannot be considered as a good comparable. Continental Device India Ltd - There is no dispute that the assessee is also in the business of manufacturing and assembly of various types of components and equipments as well as testing of opto-electronic equipments. The assessee has not given the description as how the equipments manufactured and assembled by the assessee are different from the equipments manufactured by this company. It appears that the assessee was also manufacturing additional mechanical and electronic items during the year under consideration apart from the assessee has undertaken DRUSTI project of BSF which itself shows that the equipments supplied by the assessee to BSF and Defence establishments are related with the hand-held imager which is similar to the device used for better image facility of distance objects. In the absence of detailed product description, it is not possible to give a finding how the product manufactured/assembled by the assessee are different from the product of this company. Accordingly, we set aside this issue to the record of the TPO for proper verification and adjudication of the issue of comparability of the products manufactured/assembled by the assessee as well as this company. As regards the objection regarding high-fixed asset cost, we do not find any substance in this objection because of the fact that this is in any case going to reduce the operating margin of the comparable and therefore, the assessee is not adversely affected. Further, as we have considered this issue while deciding objection of the assessee in respect of SPEL Semi conductor Ltd., accordingly, this objection is rejected and the functional comparability of this company is remanded to the record of the TPO/AO. Centrum Electronics - As it is clear from the findings of the DRP that this company is in the activity of design and manufacturing of electronic products and caters to the Defence and aero space industry. Therefore, the DRP has considered only the field of operation of the product being Defence without giving finding of the similarity of the product itself. Defence and Aero space may be using a variety of products and all may not be identical and similar. Accordingly, we set aside this issue to the record of the TPO/AO for proper verification of the description of the product manufactured/assembled by the assessee as well as by this company and then decide the comparability of this company after considering the objections of the assessee. Opto Circuits (India) Ltd. company was found engaged in the manufacture of cardio vascular equipment and devices. The revenue has not produced any record or fact before us to dispute the factual finding of the DRP that this company is in the activity of manufacturing of entirely different product which is used for medical and health care purpose. Therefore, we do not find any error or illegality in the finding of the DRP in rejecting this company being functionally not comparable with that of the assessee. Portescap India Pvt. Ltd. - Functions and the equipments of this company are entirely different from the product of the assessee. Accordingly, we do not find any reason to interfere with the finding of the DRP when the facts recorded by the DRP are not disputed by the revenue. FCI Oen Connectors Ltd. - This company manufactures electronic equipments and accessories. Since electrical equipments are different from the equipment manufactured by the assessee which are in the nature of image enhancement equipment, therefore, this company cannot be considered as functionally comparable with the assessee. Accordingly, we do not find any error in the order of Ld. DRP. Motherson Tradings Ltd. - As it is clear from the description of the product manufactured by this company the same cannot be compared with the product of the assessee. Accordingly, we do not find any error in the finding of the DRP. Reed Relays & Electronics India Ltd. - We find that these switches and key boards are not comparable with the product of the assessee and therefore, this company cannot be compared with that of the assessee for the purpose of determining the ALP. Moser Baer India Ltd - There is no dispute that this company is in the business of manufacture of storage optical media which is entirely different product with that of the assessee. Therefore, we do not find any error or illegality in the finding of the DRP by holding that this company cannot be considered as functionally comparable with that of the assessee. The objections raised by the department are rejected. Since most of the comparables which were selected by the TPO are found to be non-comparable and some of the companies are now set aside for fresh verification, therefore, if in remand proceedings the TPO finds that original comparables selected by the TPO are not functionally comparable or good comparable for the purpose of ALP, then the assessee as well as the TPO are free to carry out the fresh search and bring the comparable companies for the purpose of determining the ALP. ISSUES PRESENTED AND CONSIDERED 1. Whether the Comparable Uncontrolled Price (CUP) method could be applied as the Most Appropriate Method (MAM) to benchmark purchases from an Associated Enterprise (AE) where the assessee also purchases from non-AEs. 2. Whether the Taxing Authority's adoption of the Transactional Net Margin Method (TNMM) as MAM was justified when CUP was asserted by the taxpayer. 3. Whether the set of comparables selected by the Transfer Pricing Officer (TPO) are functionally comparable to the assessee for TNMM benchmarking, specifically in respect of: (i) S P E L Semiconductor Ltd.; (ii) Centum Electronics Ltd.; (iii) Continental Device India Ltd.; and (iv) Centum Electronics Ltd. (noting the record required verification for related party transactions for one firm). 4. Whether the Dispute Resolution Panel's (DRP) exclusion of six of the ten comparables selected by the TPO was justified on the facts and circumstances of the case. ISSUE-WISE DETAILED ANALYSIS - ISSUE 1 & 2: CUP v. TNMM (choice of MAM) Legal framework: Transfer pricing rules require selection of the Most Appropriate Method under Rule 10C(1) and 10C(2) (principle-based choice among CUP, TNMM, etc.), and CUP requires specific, verifiable data showing identical or highly comparable uncontrolled transactions. Precedent treatment: The authorities below relied on tribunal decisions holding that CUP cannot be applied in the absence of exact and specific comparables (cited tribunal decisions involving inability to compare invoices/products where detail lacking). Interpretation and reasoning: The TPO rejected CUP because invoices and product descriptions provided by the taxpayer did not establish that items purchased from AE and non-AE were identical. The DRP agreed, emphasising that CUP requires specific data and clarity on product specifications; without such data CUP is inapplicable. The Tribunal noted the assessee failed to produce requisite product specifications, purchase ratios or other detailed evidence before any authority, and raised that omission before the Tribunal as well. In those circumstances, TNMM (an indirect transactional profit method reliant on functional comparability and operating margins) was held to be appropriately applied by the TPO and upheld by the DRP. Ratio vs. Obiter: Ratio - where invoices/specifications do not establish identical products, CUP cannot be adopted as MAM; TNMM may be applied as the appropriate alternative. Obiter - reference to other tribunal decisions as supportive authority. Conclusions: The rejection of CUP and adoption of TNMM as MAM was upheld because the assessee did not furnish specific, comparable product data necessary for CUP. No infirmity in TPO/DRP choice of TNMM given the evidence lacunae. ISSUE-WISE DETAILED ANALYSIS - ISSUE 3: Comparability of Specific Companies under TNMM Legal framework: For TNMM benchmarking, comparables must be functionally comparable - similarity of functions, assets and risks (FAR), and quantitative/qualitative filters must be applied; related party transactions in a comparable's turnover can disqualify it. Precedent treatment: Authorities below and Tribunal assess functional comparability based on product/field of operation and available public records; where objections were not raised earlier, Tribunal allowed remand for verification rather than immediate exclusion. Interpretation and reasoning - S P E L Semiconductor Ltd.: The assessee argued divergence due to integrated circuit manufacturing and substantial fixed assets. The Tribunal held the core activities (assembly/testing of semiconductor components) are functionally similar to the assessee's assembly, manufacture and testing of opto-electronic equipment; difference in fixed assets alone does not preclude comparability and may, if anything, lower the comparable's margin. The assessee's objection on fixed assets was first raised before the Tribunal and could not be entertained as a fresh objection to overturn earlier findings. Ratio vs. Obiter: Ratio - a difference in scale of fixed assets, raised belatedly, does not automatically defeat functional comparability where functional activities (manufacture/assembly/test) align. Conclusions for S P E L: Comparable retained; assessee's new objection on fixed assets rejected. Interpretation and reasoning - Centum Electronics Ltd. (first reference): The assessee contended the company produced frequency control products and had high related party transactions (RPT). The DRP found the company designs and manufactures electronic products catering to defence/aerospace - a similar field of operation. Tribunal held that similarity of field is not definitive of product similarity and remanded the question for TPO/AO verification of product descriptions; the Tribunal directed that if RPT exceeds 25% the company should be excluded. Ratio vs. Obiter: Ratio - field of operation similarity is insufficient; detailed product description and RPT analysis must be verified by TPO/AO. Obiter - guidance that >25% RPT undermines a comparable's suitability. Conclusions for Centum Electronics (first): Issue remanded for verification of product comparability and RPT percentage; comparability not finally confirmed on record. Interpretation and reasoning - Continental Device India Ltd.: The assessee argued difference because company manufactures transistors/diodes and has high fixed assets. The Tribunal noted the assessee failed to demonstrate how products differ and that the assessee itself undertakes manufacturing/assembly/testing for defence projects (e.g., handheld imagers). Absent detailed product descriptions, comparability cannot be ruled out; objections on fixed assets were rejected as not determinative. Tribunal remanded to TPO/AO for specific verification and adjudication. Ratio vs. Obiter: Ratio - absence of product detail from assessee precludes exclusion; differences in fixed assets are not decisive against comparability where functions align. Obiter - product description verification is essential. Conclusions for Continental Device: Remanded for TPO/AO verification of product similarity; not excluded on record. Interpretation and reasoning - Centum Electronics (second reference): DRP considered it functionally comparable as it designs and manufactures electronic products for defence/aerospace; Tribunal noted field similarity alone may be insufficient and remanded to TPO/AO for verification of product descriptions and comparability. Conclusions for Centum Electronics (second): Issue remanded for verification; functional comparability to be established on detailed product facts by TPO/AO. ISSUE-WISE DETAILED ANALYSIS - ISSUE 4: DRP's Exclusion of Six Comparables Selected by TPO Legal framework: DRP may exclude comparables if they are functionally dissimilar on the basis of recorded facts; appellate authority will test whether factual findings are supported by record and not disputed. Interpretation and reasoning: The DRP excluded six comparables (Opto Circuits, Portescap, FCI Oen Connectors, Motherson Tradings, Reed Relays, Moser Baer) after recording product/field facts showing different end-products (medical devices, surgical motors, electrical accessories, automotive fuses, reed switches/keyboards, optical storage media). The revenue did not produce material to rebut the DRP's factual findings. The Tribunal found no error in the DRP's exclusions where the DRP's factual basis was undisputed. Ratio vs. Obiter: Ratio - where DRP records undisputed factual differences in product/function, exclusion of comparables is justified. Obiter - departments must produce contrary evidence if challenging DRP findings. Conclusions: DRP's exclusion of the six comparables was upheld as factually supported and undisputed by revenue. REMEDIAL DIRECTION Where comparables were set aside for further verification (notably two or more companies where RPT or product similarity required factual inquiry), the Tribunal remanded those issues to the TPO/AO for fresh verification and adjudication; if original comparables are found unsuitable on remand, both parties are free to undertake a fresh search for comparables. FINAL DISPOSITION Part allowance of the assessee's appeal: CUP rejection and TNMM adoption upheld; certain comparables excluded by DRP upheld; comparability of specified remaining companies remanded to TPO/AO for verification (including verification of related party transactions where not previously examined). Revenue's appeal against DRP exclusions dismissed.